Sunday, February 28, 2010

What do rational savers and investors do in an environment of zero percent interest rates, where the daily headlines speculate how long major currencies (like the U.S. dollar) will hold their value as national debts mount?

Switch (at least) a little of their holdings to gold.

Even if that amount is relatively small -- say, 5% of liquid assets -- the effect on global commerce could be huge.

That's because 5% of global liquidity is still a huge number, and it's magnified many times that by something called a "fractional reserve banking system."

"Fractional reserve what???"

If you're not an economics wonk, stop here; however, if you can handle a little bit of brain teasing . . . . read on.

Global Money Supply: How Much?

To figure out how much 5% of the world's money supply is, one first has to estimate . . . the world's money supply.

If you know, send me an email.

However, as best I can tell, a working estimate is about $30 trillion.

That consists of both coins and legal tender, as well as short-term banking deposits, money market funds, CD's, and the like.

While definitions vary, to be included in the foregoing number, the instrument must be liquid -- that is, easily converted to cash and spendable.

What's the big deal if people effectively put a trillion (or two) in their mattress?

Due to something called "fractional reserve" banking -- the system in developed countries today -- $1 on deposit at a bank theoretically can support $20 of loans. That's because banks typically only need to keep $1 in reserve for every $20 they lend.

So, a $1 trillion withdrawal potentially has the effect of reducing lending activity by $20 trillion.

That, in an economy where assets like stocks and housing have already taken multi-trillion dollar hits the last two years or so.

Missing Drain Plug?

To combat this contractionary dynamic, the Federal Reserve and other central banks have been, shall we say, "aggressively" increasing liquidity -- printing money.

Unfortunately, as central bankers have poured money into the global currency "bath tub," they haven't seem to notice that there's a big hole in the drain plug -- if indeed there still is a drain plug.

Ironically, it may even be the case that the more "fiat" (paper) money central bankers create, the more people defensively convert that money to non-fiat forms -- like gold -- to protect themselves.

Addressing this vicious circle -- and removing the "gold tax" -- would seem to be the biggest imperative for today's monetary policy makers.

P.S.: economists have various terms for times -- like now -- when monetary policy seems to be impotent (or worse). They include "pushing on a string," "liquidity trap," etc.

About Ross Kaplan

Ross Kaplan, 50 years old, is a realtor in Edina Realty's City Lakes (Minneapolis) office. He is also a former attorney (corporate law) and CPA, and holds an economics degree from Stanford. Ross is a three-time "Super Realtor," named by Mpls.-St. Paul Magazine and Twin Cities Business Magazine, and is a repeat member of Edina Realty's "Leadership Circle," awarded to the company's top 5% in sales volume. He served two terms on the local Board of Realtors' Professional Standard Board, which adjudicates ethics complaints and other industry issues. Ross' real estate practice focuses on Minneapolis and the West suburbs. He lives in Minneapolis' Sunset Gables neighborhood with his wife and three kids.
Ross' Journalism credentials: trivia question . . what do Ross and (NY Times columnist) Thomas L. Friedman have in common? They both were editors of the St. Louis Park high school newspaper, the Echo (Ross in '78, Thomas Friedman in '71). Ross' frequent articles and op-ed pieces have appeared in The New York Times, Star Tribune, Minneapolis-St. Paul City Business, RealClearMarkets.com, and numerous other publications -- online and off!